Surging spot prices of iron ore are forcing steel mills to look for more domestic supplies, something that would also reduce their dependence on costly imports, industry insiders said.

Beijing Ye-Steel Trading Co, a private steel mill that buys ore from the spot market, has stopped buying imported iron ore after prices surged to above $130 per ton in February.

"We are now buying domestic iron ore with a 66 percent iron content priced at 1,080 yuan ($158) per ton including tax, much cheaper than imported ore," said a sales manager from Ye-Steel who declined to be named. The company is one of several steelmakers choosing domestic iron ore sources more often.

Industry analyst Xu Xiangchun from consulting firm Mysteel said that since the spot price of imported iron ore is higher, many steel mills have increased offtake from domestic sources, especially from Hebei province where most of China's mines are located.

This should help to keep rising imported iron ore prices in check, he said.

As to whether the domestic sourcing option will impact annual benchmark price talks - which are currently ongoing - is hard to say, he said.

The price of 66 percent content ore from Iran rose to $144 per ton including freight on Thursday - more than double the 2009 benchmark price reached by Australia's Rio Tinto, BHP and Brazil's Vale.

That price is 7 percent higher than domestic ore, and if taxes are included, the price is nearly $168 per ton.

Ye-Steel's sales manager said domestic ore accounted for a mere 5 percent of the company's raw material consumption in 2009, as the global financial crisis weighed on imported ore prices.

But after spot prices of imported iron ore rose to a record high this year, he expects domestic supplies to account for 30 percent of the company's raw material usage in 2010. Since the domestic ore has a lower percentage of iron, it comes with higher mining costs attached to it.

Xu said low-priced spot ore imports last year squeezed domestic miners' margins, even pushing some out of business. But when imported ore prices jumped above domestic pricing levels, China's miners shifted back to sourcing from the local markets.

Domestic iron ore production stood at 200 million tons in 2009 and is likely to rise by 20 percent in 2010, he said.

Chinese steel mills are at a disadvantage in the annual iron ore price talks due to the large number of steel firms scattered across the nation, and their high dependence on imported iron ore.

Steel mills increased iron ore imports by 42 percent to a record 628 million tons in 2009.

Imported ore, on average, accounted for 62 to 69 percent of the total offtake by Chinese steel mills, according to official data.